Energy prices in the UK: the return to regulated tariffs?

Energy prices have been in the eye of the storm for some time in the UK. The weeks before the June 2019 elections saw both political parties promising not to change price caps to consumers. This alarmed several analysts and energy economists in particular as the long-standing caps could –according to many- stifle competition and reduce opportunities for new entrants in the market. Others took this opportunity to emphasise the several failures of the liberalisation of energy markets in the UK and the return of regulated tariffs over liberalised tariffs.

This is an opportunity to reflect on the different needs around pricing given current constraints and future aspirations of the electricity system. Two issues are discussed here: (i) the need to keep prices down for vulnerable consumers; and (ii) the need for flexible tariffs.

The UK Government introduced price caps (i.e. a maximum £/Kwh price of electricity and gas for vulnerable consumers) two years ago in a first U-turn on the liberalisation of tariffs which has been taking place since the 1990s. The discussion on capping prices is a reminder of the concerns from large portions of the population around affording energy bills. More than 2.3 million households are living in fuel poverty in England – the equivalent of 10% of households. The aggregate fuel poverty gap for England is at £884 million. The main factors for vulnerable consumers are low incomes and energy (in)efficiency of the homes they live in (for instance, the proportion of households in fuel poverty has the lowest levels of insulated cavity walls). The most vulnerable consumers (so called ‘fuel poor’) are defined as having fuel costs that are above the national median level and being left with a residual income below the official poverty line after spending for fuel costs. Household income, household energy requirements and fuel prices are three important elements in determining whether a household is fuel poor. It has been noted that under different fuel poverty measurement methodologies, the number of households defined as fuel poor could be even double compared with current Government estimates.[1] Capping prices is only one of the many ways of avoiding that vulnerable consumers pay ‘too much’ for their energy bills. Other examples consist of: increasing incentives on energy efficiency, strengthening and supporting the Home Energy Conservation Act, and enhancing the level of support to local councils’ initiatives.   

Imbalances between demand and supply are becoming an increasingly significant problem for UK electricity networks as they cause negative impacts on system costs and the environment. The residential sector is responsible for about one third of overall electricity demand and up to 40% of peak demand. During peak demand, electricity prices in wholesale markets could fluctuate from less than €0.04/kWh to as much as €0.35/kWh.[2] In a decarbonised future, peaks are likely to remain an issue where capacity margins are slim, particularly in seasons with issues where the problem is exacerbated by weather (e.g. winter in the UK and summer in parts of the U.S.). Flexibility will be required for even more frequent issues of demand and supply balancing are likely to occur on a daily basis due to the high penetration of intermittent renewable sources on the one hand and increasing implementation of electric heating and transport on the other hand.

Time of Use tariffs offer significant potential benefits to the system by enabling responsive electricity demand and reducing peaks. For example, they could reduce the need for new generation and network capacity.

Flexibility comes at a price. The most recent example we have is from Ofgem removing embedded incentives. In 2017 Ofgem cut subsidy payments for small plants producing electricity at peak times from £47 per kilowatt to between £3 and £7 per kilowatt. The change will be fully implemented by 2021. The regulator believes the changes will prevent market distortion and reduce consumers' energy bills by up to £370m a year.

However, lack of flexibility comes at a price too. Studies suggest that in an inflexible UK delivering future-proof energy infrastructure electricity system, with 30GW of variable renewables and inflexible nuclear generation, up to 25% of wind energy may need to be curtailed due to the increased need for fossil fuel generation to operate part-loaded in order to provide required ancillary services. Moreover, the value of the technical potential of the flexibility market was estimated to be around £8 billion per year by the National Infrastructure Commission.[3] This includes flexible technologies, such as: flexible generation, interconnection and flexible network technologies, demand-side response, and energy storage.

Keeping prices down for vulnerable consumers and introducing cost-reflectiveness into tariffs intuitively may be conflicting objectives.

The impact of cost-reflective pricing will vary between consumers. In particular, those who consume electricity at more expensive peak periods, and who are unable to change their consumption patterns, could end up paying significantly more.  

Understanding the distributional effects of Time of Use tariffs becomes vital to ensuring affordability of energy bills, at the same time as making demand more flexible. Analysis on the distributional effects of Time of Use pricing is very limited.